In bad times, Wall Street reaches for God and charts, says John Dizard
At moments of loss, people, even financial people, turn to religion. While Wall Street has a public posture of tolerance, agnosticism and cynicism, it has its own private faith: technical analysis. Most of the time, at least when portfolio managers and other market professionals are talking to the investing public, it is a faith that is only expressed sotto voce, or with passing references.
In really bad markets, all those expensively informed professionals are on the phone to each other, talking nervously about “support levels” or “breakouts”.
Technical analysis, or the “charting” of financial markets, refers to the study of the actions of the market itself, in prices and volumes of trades, as distinct from “fundamental” analysis, or the close examination of income and balance sheet statements, industry data and macroeconomic indicators.
Fundamental analysis is the classy thing to do. Limited partners and investment committees want you to talk about, say, the alumina supply/demand balance, the cost of megawatts in yuan for Chinese aluminium producers, or the increased use of aluminium by Ford and Toyota. After the eye-watering three-hour presentation, though, almost every pitch will end with something like: “Alcoa [the aluminium producer] is forming a tradable low here.”
Dennis Gartman, author of the eponymous daily newsletter, frequent CNBC guest and experienced investor, says: “Technical analysis is always being snubbed. But I like it because it can force you to admit when you are wrong. If I am bearish, I want prices to move from the upper left to the lower right. If I am bullish, I want prices to move from the lower left to the upper right. Are trend lines being broken on the upside or downside? Yes, my technical analysis is simplistic. I take simplistic as a badge of honour.”
The underlying thesis of technical analysis is that all information in a traded asset or an index of traded assets is reflected in the price. It follows that asset price movements tell you more than the formally exchanged news about the asset. Or, as one London investor told me when I started in this business: “There are two ways to trade: inside information or technical analysis.”
The techniques of standard analysis are not difficult to learn or even that obscure. One textbook by Robert Edwards and John Magee, Technical Analysis of Stock Trends, first published in 1948, is now in its 10th edition. What is difficult is the tactical application of the principles and the necessary Zen-like detachment from existing positions.
Of course, there are people who can claim to have moved beyond the Edwards and Magee canon. Charles Nenner, a Dutch medical doctor, worked out his own theory of investment cycles when he noticed that behavioural patterns such as psychiatric admissions or child bearing followed the phases of the moon.
Mr Nenner and his partners have had a good run lately. They tried to wave their advisory clients to the risk asset exit lane at the beginning of the year, and correctly called the continuing bear market in crude oil. Now, according to David Gurwitz, managing director of Charles Nenner Research Center, crude is close to its low for the year. “We think it bottoms at around $25 per barrel, then rises to $60 or more by the end of the year.”
As for equities, Mr Nenner and Mr Gurwitz believe this year's low in the indices will come in April. “The big top for the decade only comes in the middle of next year,” Mr Gurwitz says. Why? “We don't know why. We just find repeating patterns in the price cycles.”
Martin Pring, co-founder of Pring Turner Capital Group, has developed a proprietary technique for measuring “momentum”, or the rate of change in asset prices. He uses his system to express one market's prices in relation to others, such as US junk bonds to Treasuries, global equities to commodities, bonds to spot raw commodities, or high-tech equities to consumer durables.
One of his favourites is junk bonds to Treasuries. “It has been a great indicator for the past 10 to 15 years, much more than it was before then. It depends on whether you have a stable or unstable financial system. Now I would say that credit players tend to be smarter than stock players.”
The professionals tend to pooh-pooh one of the most elaborate technical analysis techniques, the Elliott wave theory, which is about charting a five-wave up and down movement of asset prices. According to Mr Pring, “you can go back [after the fact of an up or down price move] and fit it to the facts”. Mr Gartman agrees: “Those guys [Elliott wave enthusiasts] are always revising what wave count they use.”
It would be fair to say the technical analysts have a pretty gloomy outlook for risk capital. Mr Pring says: “The balance of evidence [for equities] is overwhelmingly bearish, but we are due for a fool's rally.”
That is not quite as bearish, though, as one of Mr Nenner's charts. “We also look at war cycles. Every second decade for the past 20 centuries there has been a major war. Major is not Iraq.”